There is a saying, “It takes one to know one.” I am a convicted felon, former CPA, and former criminal CFO of Crazy Eddie. Today, I teach law enforcement agencies and professionals how to identify fraud and train them to catch the crooks. This blog investigates white-collar crime, securities fraud, accounting irregularities, corruption, and other related topics. Accounting irregularities investigated by me are referred to appropriate government agencies as a whistleblower.

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Wednesday, January 20, 2010

Roddy Boyd Article Will Cause SEC to Expand Investigation of Overstock.com and Probably Result in Sales Tax Investigation by New York

The Big Money published an article by investigative reporter Roddy Boyd will result in an expanding Securities and Exchange Commission of Overstock.com (NASDAQ: OSTK) and probably a new investigation by the New York State Department of Taxation and Finance for possible tax evasion by the company. Big Money obtained internal Overstock.com documents showing how the company withheld material information from investors about the company's internal control problems and liquidity problems in 2005 and 2006. The article details how CEO Patrick Byrne systematically intimidated, harassed, and attacked his critics to cover up mounting problems at the company. Perhaps the most surprising revelation of Roddy Boyd's article is Overstock.com's efforts to evade paying New York State sales tax in what was known as "Operation Heist and Freeze."

New Issues for SEC to Investigate

The Securities and Exchange Commission, which started investigating Overstock.com after this blog exposed its improper use of "cookie jar" reserves to inflate its financial performance, will surely expand its investigation based on information provided in Roddy Boyd's article. For example, the article details that internal Overstock.com documents revealed that the company's "software system couldn’t track its inventory well, its accounting staff had trouble deciphering how much it owed and whom it had to pay."

However, my examination of Overstock.com's SEC filings finds that CEO Patrick Byrne and CFO David Chidester both signed Sarbanes-Oxley certifications for financial reports claiming that the company had effective internal controls over financial reporting, while internal company documents obtained by The Big Money contradict their representations to investors.

It later turned out that those financial reports were restated two times: in February 2006 due to inventory accounting errors and in October 2008 due to customer refund and credit errors. Overstock.com faces a third restatement of those same financial reports due to its improper use of "cookie jar" reserves that were exposed in this blog and are being investigated by the SEC. Therefore, Patrick Byrne's and David Chidester's Sarbanes-Oxley certifications were not only false, apparently they were deliberately false based on documents obtained by The Big Money!

In any case, the SEC investigation is already heating up. Just two days ago, Carol Remond from Dow Jones Newswires reported that the SEC subpoenaed Copper River for discovery documents obtained from Overstock.com during its legal battle with the company. Apparently, the SEC hopes that documents obtained by Copper River will help its investigation of financial reporting violations by Overstock.com.

Probable Tax Evasion Investigation by New York State

As I detailed above, Roddy Boyd's article provides damning evidence of possible tax evasion by Overstock.com. After speaking to New York State Department of Taxation and Finance, I am sure that they will be looking into this matter. See excerpt from Roddy Boyd's article below:

Another instance of Overstock critics having the correct instincts, but getting some of the details wrong, is in the confusion surrounding the announcement of Overstock’s design-your-own-jewelry initiative in 2006. Pitched as a value-conscious alternative to online jewelry leader Blue Nile, and offering better quality than Wal-Mart—“For what you would spend elsewhere, you can get her a lot more diamond here,” went the slogan—Overstock dove into the bitterly competitive online jewelry market in January 2005.

What caught the attention of critics was its announcement in the first quarter 10-Q filing in May of 2005 that it had set up a “variable interest entity” to engage in these transactions. The entity had agreed to lend Overstock up to $10 million—$8.4 million of which had been extended in November 2004—for which it received a below-market interest rate of 3.75 percent and a 50 percent claim to all profits. Overstock also had an option to buy the 50 percent it did not own.

Jeff Matthews, a hedge-fund manager, author, and blogger who had long been critical of Overstock and Byrne, immediately seized on the unusual structure of the transaction. He wondered why Byrne, who had discussed the great opportunities they were seeing (and participating in) within the diamond market that January, had not disclosed something as material as the joint venture.

Gradient, in a research note on May 16, 2005, offered a more detailed criticism. The report raised several questions about the deal, including whether the deal was structured as a variable interest entity to “report the top line benefits of the jewelry business without reporting 100% of the unit’s losses.” For a company whose losses, even before the debacle of the software upgrade, were mounting, this was—to Gradient at least—a plausible scenario.

But the truth is much simpler: The deal seems to have been a tax dodge. The joint venture, struck with Moshe Krasnanski and his brother-in-law Mayer Gniwisch—a pair of veteran diamond merchants whom Byrne referred to as “Our Lubbavitcher friends”—had nothing to do with efforts to minimize accounting losses. In an e-mail to the board of directors, Byrne dubbed the process of recruiting the pair, who had set up the profitable online diamond-seller Ice.com, “Operation Heist and Freeze.” According to a memo, Overstock general counsel Jonathan Johnson prepared for the board of directors on July 13, 2005, the company’s VIE was designed to avoid a “nexus in the State of New York for sales tax purposes,” which means that the company would not have to collect, and pay out, sales taxes in the state. The diamond sales effort never really went anywhere for Overstock, and it was closed out during the holidays of 2006 with about $567,000 in accumulated losses, according to an internal balance sheet for the joint venture.

Note: Bold print and italics added by me.

Having done battle with New York's sales tax auditors as the criminal CFO of Crazy Eddie, I learned the hard way that they are more tenacious than mob collectors in retrieving monies owed - no offense to the SEC, FBI, or IRS. Under New York law, company officers are not protected by the corporate veil and are personally liable for any sales tax deficiency.

I am a convicted felon and a former CPA. As the criminal CFO of Crazy Eddie, I helped Eddie Antar and other members of his family mastermind one of the largest securities frauds uncovered during the 1980's. I committed my crimes, simply because I could.

If it weren't for the efforts of the FBI, SEC, Postal Inspector's Office, US Attorney's Office, and class action plaintiff's lawyers who investigated, prosecuted, and sued me, I would still be the criminal CFO of Crazy Eddie today.

I do not own Overstock.com securities short or long. My research on Overstock.com and in particular its lying CEO Patrick Byrne is a freebie for securities regulators and the public in order to help me get into heaven, though I doubt that I will ever get there anyway. I will probably end up joining corporate miscreants such as Patrick Byrne in hell. In any case, exposing corporate crooks is a lot of fun for a forcibly "retired" crook like me and analyzing Overstock.com's financial reporting is a forensic accountant's wet dream.

I have done free training for New York State Department of Taxation and Finance in the past.

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“White collar crime is more brutal than violence crime. The actions of one or a few corrupt public officials and corrupt businessmen affect the livelihoods of thousands of people. Treat them with the same disdain as we do treat serial killers because white collar criminals are economic predators. We are serial economic predators." -- Testimony of Sam Antar